2 Unclassified TD/TC/WP(2006)11/FINAL TD/TC/WP(2006)11/FINAL Unclassified Organisation de Coopération et de Développement Economiques Organisation for Economic Co-operation and Development 12-Oct-2006 English - Or. English TRADE DIRECTORATE TRADE COMMITTEE Working Party of the Trade Committee FACILITATING ADJUSTMENT: SECTOR EXPERIENCES FROM AGRICULTURE, TELECOMMUNICATIONS AND CHEMICALS OECD Trade Policy Working Paper No. 41 by Michael Engman, Osamu Onodera and Norbert Wilson English - Or. English All Trade Working papers are now available through OECD's Internet website at: JT Document complet disponible sur OLIS dans son format d'origine Complete document available on OLIS in its original format

3 ABSTRACT This paper is a follow-up study to Trade and Structural Adjustment: Embracing Globalisation (OECD 2005) which identified policies for successful trade-related structural adjustment. It draws further policy implications through the analysis of three sectors which were not specifically/fully covered in the initial report: agriculture (tobacco and coffee), telecommunications and chemicals. The report consists of two parts. The first part summarises the policy implications drawn from the sectoral case studies while the second part presents the case studies. The study draws some new policy lessons in terms of the usefulness of multilateral commitments, effects of domestic regulations that limit the ability of producers to supply markets (such as licensing and production quotas), potential issues related to state ownership in certain sectors of the economy, relationship between the public and private sectors in the adjustment process, role of subsidies, and sequencing and pace of reform. The case studies on agriculture (tobacco and coffee), telecommunications and chemicals highlight the diverse nature of the adjustment process both among sectors and different groups of countries. The following country experiences are reviewed in the respective sectors with varying emphasis: Brazil, Vietnam, Central America and East Africa in coffee; United States, European Union, Brazil, China and Malawi in tobacco; Morocco, Argentina and India in telecommunications; United States, Europe, Japan, Korea, ASEAN, China, Mexico and Saudi Arabia in chemicals. Keywords: trade, structural adjustment, agriculture, coffee, tobacco, telecommunications, chemicals, petrochemicals, Brazil, Vietnam, Central America, Costa Rica, El Salvador, Guatemala, Honduras, Nicaragua, East Africa, Kenya, Tanzania, Uganda, United States, European Union, China, Malawi, Morocco, Argentina, India, Japan, Korea, ASEAN, Mexico, Saudi Arabia, reform, adjustment, multilateral commitment, multilateral rule making, trade remedies, safeguards, anti-dumping, trade liberalisation, domestic regulations, state-owned enterprises, subsidies, sequencing, investment ACKNOWLEDGEMENTS This project was carried out by Osamu Onodera, Norbert Wilson and Michael Engman under the supervision of Anthony Kleitz and Kenneth Heydon of the OECD Trade Directorate. At the OECD, colleagues inside the Trade Directorate, Directorate for Food Agriculture and Fisheries, Directorate for Science, Technology and Industry, Directorate for Development Cooperation and the Development Centre provided inputs and helpful comments. The authors wish to thank CEFIC (European Chemical Industry Council), Japan Chemical Industry Association, Japan Petrochemical Association, Jacque Autin, Wolfgang Hehn, Luc De Meyer, Chihiro Momose, Kiyotaka Oyama, Alain Van Raek, Tadahisa Sasano, Rene van Sloten and Lee Tuthill for valuable input and/or helpful comments to an earlier version of this paper. The Working Party of the OECD Trade Committee discussed this report and agreed to make the findings more widely available through declassification on its responsibility. The study is available on the OECD website in English and French: Copyright OECD 2006 Application for permission to reproduce or translate all or part of this material should be made to: OECD Publications, 2 rue André Pascal, Paris Cedex 16, France. 2

7 EXECUTIVE SUMMARY This paper is a follow-up study to Trade and Structural Adjustment: Embracing Globalisation (OECD 2005) which identified policies for successful trade-related structural adjustment. It draws further policy implications through the analysis of three sectors which were not specifically/fully covered in the initial report: agriculture (tobacco and coffee), telecommunications and chemicals. As it is a follow-up study focusing mainly on the trade policy related aspects, some important issues that were covered in the original report such as macroeconomic policy and labour policy are not covered explicitly. Thus this paper should be read in conjunction with the original report, in particular when considering policy implications. The report consists of two parts. The first part summarises the policy implications from the sectoral case studies while the second part presents the case studies. The case studies highlight the diverse nature of the adjustment process both among sectors and different groups of countries. While some of the policy lessons cannot be readily transferred to other settings, some common themes emerge. The first theme relates to how multilateral/plurilateral commitments and rules can facilitate structural adjustment. Broadly speaking, trade and investment liberalisation can facilitate the structural adjustment process by providing markets for new industries. Multilateral commitments may lock in trade and investment liberalisation by making backtracking difficult. Commitments on future liberalisation may act as a trigger for economic reform and facilitate structural adjustment by providing a roadmap for future liberalisation and reform. Scheduled reform may reduce the risk of regulatory reform reversals and foster business confidence that can facilitate investment in areas which benefit from reform. Similarly, multilateral rule making tends to promote good regulatory practice, such as transparency and promotion of competition, in relation to the implementation of commitments. This may especially be important for developing countries with limited governance institutions and experience. Although trade remedies such as safeguards may have potential benefits by providing breathing space for structural adjustment, excessive or improper recourse to such measures may delay structural adjustment. The second theme relates to how domestic regulations can facilitate or hinder structural adjustment. Domestic regulations are a key determinant in the framework for structural adjustment; at the same time they are increasingly relevant in the context of multilateral trade rules. All case studies illustrate how domestic regulations that limit producers ability to supply markets (such as licensing and production quotas) reduce competition, opportunities for investment and the private sector s ability to respond efficiently to market signals. State ownership which reserves certain sectors of the economy to the state may be a case in point. While state ownership may play a useful role in the economy, it may also delay the structural adjustment process if it leads to slow responses to changing markets. Review of such domestic regulations including state ownership if managed properly can yield significant benefits. The third theme relates to the role of the public and private sectors in structural adjustment. The private sector firms and individuals is the main player in structural adjustment. However, governments can also play a constructive and sometimes decisive role. In areas where there is state-ownership or where there are existing government regulations which pose direct restrictions on entry to or exit from a certain sector, government action may be necessary for effective adjustment. The government also plays a key role in providing a broad enabling policy environment. While direct government intervention in the adjustment process may be warranted in some cases, such intervention needs to be handled with care to assure an efficient outcome. Subsidies or other governmental action to minimise social dislocation by delaying structural adjustment should be transparent and time bound. Unnecessary delay in structural adjustment may lead to greater and more difficult adjustment later on, especially if it keeps inefficient producers in the market. Structural change may have differential effects on different groups and it is not 6

8 always possible to have a predetermined single policy to meet all needs. In such cases it may be realistic to move ahead with reform while providing for flexible and decentralised adjustment policies to be provided based on local information. As is the case with national policy, such decentralised policies must be timebound and provide a clear exit strategy. In addition, public-private partnerships may be effective in a world of imperfect information and market imperfections, allowing both governments and industry to better understand structural trends. The fourth theme relates to sequencing and pace of policy reforms. Economic reform and trade liberalisation often entail several elements of reform which are pursued in parallel. While it is possible to pursue one or the other sequentially, all elements of reform are often mutually reinforcing. In telecommunications for example, privatisation, introduction of competition, and establishment of an independent regulator have been effective reform measures. In this sector, competition has been the most effective agent of change and establishment of an independent regulator has been the key to introducing effective competition. Privatisation without effective regulation has not necessarily improved service levels, yet establishment of independent regulatory authorities prior to privatisation has had a positive effect on investment in infrastructure and telephone penetration. Gradual reform with a roadmap may ease adjustment by facilitating changes in resource allocation. Gradual reform may provide sufficient time for the private sector to react to changes. A roadmap for reform may further facilitate resource reallocation by increasing predictability and reducing risk. However, if reforms are too slow or there are indications of uncertainty in the direction and timing of reform, resource reallocation may be impeded. Liberalising input sectors may be important to allow smooth adjustment of output sectors. Parallel liberalisation of trade and investment has substantial merits. A well-functioning financial market also facilitates structural adjustment by providing the necessary incentives for adjustment and facilitating reallocation of capital to more productive uses. The coffee case study addresses how the coffee industry has adjusted to sustained price decline, in particular, the so called coffee crisis where coffee prices fell to 100- year lows between 1999 and The dismantling of the International Coffee Agreement and national marketing boards, the boost of Brazilian coffee supply, the entrance of Vietnam as a leading coffee supplier, and changes in consumer preferences and technology were elements driving structural adjustment in this sector. The case of coffee is of particular interest because coffee is a product which is produced only in developing countries and mainly for developed country markets. The case study reviews experiences from Brazil, Vietnam and countries in Central America and East Africa. The tobacco case study examines cases of structural adjustment in tobacco farming. The tobacco farming industry, which is present both in developed and developing countries, has undergone substantial adjustment, brought about largely in response to change in production and consumption patterns reflecting national and global tobacco-use cessation efforts. The case study has a strong focus on the experiences in the United States; however, the policy changes and market settings of Brazil, China, European Union, and Malawi are also presented to explore how these markets have adjusted. The telecommunications case study addresses structural change and adjustment in the telecommunications sector, which has experienced profound change over the last two decades driven mainly by new technology and changing regulatory frameworks. Deregulation and re-regulation have resulted in more open and competitive markets. Trade and investment liberalisation for both telecommunications service providers and telecommunications equipment manufacturers have stimulated trade and economic growth. Starting with a cross-country study on the global telecommunications sector, this study looks closely at the sequencing of reform in Argentina, India and Morocco. 7

9 The chemicals case study addresses the structural change and adjustment in the chemical industry, focusing on petrochemicals. Rising oil prices, technological change and increased demand have triggered a change in supply-demand patterns, which is expected to continue in the future. Starting with a crosscountry study on the global chemical industry, this study surveys experiences from Mexico, Saudi Arabia, the United States and countries in Eastern Asia and Western Europe. 8

10 FACILITATING ADJUSTMENT: SECTOR EXPERIENCE IN AGRICULTURE, TELECOMMUNICATIONS AND CHEMICALS Introduction 1. The study Trade and Structural Adjustment (OECD 2005) identifies policies for successful traderelated structural adjustment. From case studies, the study identifies good practices, which capitalise on the opportunities of structural change and aim to impose minimal costs on individuals, communities and society as a whole. The Secretariat presented the findings of the study at forums where academics and policy experts commented on the findings. 2. Based on the feedback received from those forums, it was agreed to conduct a follow-up study to draw further policy implications through the analysis of three sectors which were not specifically / fully covered in the initial report; agriculture (tobacco and coffee), telecommunications, and chemicals. 3. This paper draws more specific policy implications with regard to trade related aspects. As this follow-up paper is focused on trade policy related aspects, some important issues that were covered in the original report such as macroeconomic policy and labour policy are not covered explicitly. Thus this paper should be read in conjunction with the original report, especially when considering its policy implications. 4. This follow-up report consists of two parts. The first part below summarises the policy implications from the sectoral case studies and the second part present the case studies. PART 1: POLICY IMPLICATIONS 5. In the sectors studied, evolving global conditions made it necessary for industries to undergo structural adjustment; the reallocation of labour and capital to more efficient uses in response to structural changes. In some cases, such as chemicals in the United States, specific policy changes were not required for structural adjustment to take place; in others, structural adjustment was slowed down due to existing policy frameworks, necessitating structural reform. 1 In cases where trade protection and/or domestic regulations in place shielded industries from international markets initially (e.g. tobacco in developed countries, chemicals in China, and telecommunications worldwide), liberalisation in trade and investment was perceived as the driver of structural adjustment. It should be pointed out that even in such cases, structural change is actually driven by other factors such as technological change and change in consumer preferences; trade and investment liberalisation is merely the harbinger of structural change. In this era of globalisation, it is increasingly costly for countries to maintain trade protection and/or domestic regulations which shield inefficient industries from market forces. Protection of inefficient industries reduces welfare; but especially in industries that produce intermediate products or services, as inefficient inputs may result in user industries shifting production abroad or failing to take advantage of opportunities in new emerging industries. 1. It may be useful to differentiate the concept of structural adjustment which is the process of adjustment which does not necessarily involve government, and structural reform which is a process of policy reform that is initiated by government. 9

11 6. The case studies in this report highlight the diverse nature of the adjustment process, both among sectors and among different groups of countries. This is because industries in various countries have evolved differently based on different natural and human resource endowments, technologies, domestic regulatory frameworks, and levels of trade and investment liberalisation. Therefore, some of the policy lessons may not be readily transferable to other settings. However, there are some common themes emerging. Among the common themes are The importance of the enabling environment created by multilateral/plurilateral commitments and rules, The importance of the domestic regulatory environment, The importance of exercising caution when the state intervenes in markets and The importance of attention to sequencing of reform measures. (1) How multilateral/plurilateral commitments and rules can facilitate structural adjustment International commitments can progressively lock in practices facilitating structural adjustment 7. Multilateral commitments relating to trade or investment policies may act as a trigger for economic reform and structural adjustment. Such commitments can serve to lock in earlier liberalisation by making backtracking difficult. Forward looking commitments help countries sustain the liberalisation process and may provide a roadmap for necessary reform. These commitments reduce the risk of regulatory reform reversals and foster business confidence that can lead to higher levels of investment in sectors that benefit from the reform. International commitments may also aid domestic acceptance of reform, especially when there are stakeholders with strong vested interests in the status quo. Incumbent firms and workers who enjoy rents may accept reform if it is locked in through international commitments. Scheduled reform may reduce lobbying efforts and the associated costs. If governments have a clear intention to maintain a liberal trade regime, making binding commitments in international fora may be one way to signal its commitment to trade liberalisation This was clearly illustrated in the telecommunications sector. The post-uruguay Round negotiations in basic telecommunications acted as an external stimulus to reform. The resulting international commitments made in these negotiations served mainly to lock in liberalisation that had already been undertaken. Where countries made commitments into the future, they helped sustain the liberalisation process that was underway and served as a roadmap for reform. 3 International commitments to reform reduced risk of regulatory reform reversals. This often led to an increase in investment both by potential new entrants benefiting from reform and incumbents getting ready for increased competition. The introduction of competition in the telecommunications sector reduced employment levels in former public telecommunication operators (PTOs), 4 but investments by new operators created jobs which made up for much of the job losses in PTOs. 9. In the case of petrochemicals in Japan, the tariff reductions under the Chemical Tariff Harmonization Agreement (CTHA) served as a signal for increased global competition and the need for 2. The delayed WTO commitments in the telecommunications sector by Morocco may have been examples where countries have made commitments in the WTO to lock in scheduled reform. 3. See example of Morocco and Argentina (para ) 4. See paras 170 and

12 structural adjustment. The gradual tariff reduction commitments ending with a final reduction in the year 2004 served as a roadmap and target date for companies to plan their restructuring efforts. 5 China s tariff reductions before its WTO accession and its staged commitments upon entry to the WTO also served the same purpose for the chemical industry in China. In the case of Western Europe s chemical industry, the creation of a Single European Market focusing on reduction of behind-the-border barriers, since tariffs had already been eliminated served both as a trigger and facilitator for structural adjustment Thus, multilateral and plurilateral commitments can be of great use to a country with the intention of using trade liberalisation as a trigger for structural adjustment. However, a word of caution may be warranted. While it is often easier for governments to present such trade liberalisation as a concession to outside pressure in order to gain acceptance by industry / the public, overt reliance on outside pressure for reform may lead to lack of ownership of reform. Multilateral rule making can also be used to promote good practices 11. Multilateral negotiations and rule making may also facilitate the structural adjustment process by allowing countries to draw on their collective experiences in defining good regulatory practice. This may especially be important for developing countries with limited governance institutions and experience. For example, in telecommunications, the negotiations in basic telecommunications resulted in the creation of a reference paper, which establishes a number of regulatory principles, or best practices, that countries can choose to include in their schedules as additional commitments. These principles 7 have facilitated the transition from a regulatory framework with state-owned monopolies to one which promotes effective competition In the tobacco case, the adjustment policies undertaken by both the EU and the US seem to have been influenced by the Agreement on Agriculture (AoA). Both the EU and the US needed to reform their production quota systems, which were becoming unsustainable. While several methods could have been used in the reform, both the EU 9 and the US chose policies that only minimally affect production (decoupled policies), a core concept of the AoA. 10 According to work of the OECD, policies that are decoupled from production are more efficient in transferring benefits to the intended recipients and less trade distorting than coupled policies. 11 Decoupled policies are based on historic rather than current levels of production and do not require the beneficiary to continue to produce a particular product; they are less 5. See paras 272 and See para 265 on discussion of the effect of the Single European Market on the European chemical industry. The European experience also points out the benefits of liberalisation when the mobility of factors of production is facilitated and non-tariff barriers are dismantled, as this further liberalisation increases options for firms to adapt. 7. These principles include competitive safeguards, interconnection, independent regulation, transparent licensing procedures and non-discrimination. Anti-competitive safeguards refer to measures taken to prevent anti-competitive practices such as anti-competitive cross-subsidization, use of information obtained from competitors with anti-competitive results, etc. 8. See para 202 and The EU permits Member States to use some coupled policies for four years ( ) in its current tobacco policy reform. 10. See para and Box 7 for description of the US Tobacco buyout and para 147 for the new EU policy on tobacco. 11. See for example OECD(2002). 11

13 likely to keep producers in declining sectors (e.g. tobacco in developed countries) but rather encourage structural adjustment. Excessive/improper recourse to trade remedies such as safeguards and anti-dumping duties may delay structural adjustment 13. As noted in OECD (2005), trade remedies such as safeguards may have potential benefits in that they may provide breathing space for, and greater acceptance of, structural adjustment. However, considering that restrictions on trade are unlikely to affect the underlying structural forces, there is a need to ensure that these measures are time bound and that industry will adjust in the given period. The current safeguards agreement ensures that measures are time bound by limiting the duration of measures to an initial four years, which may be extended to a maximum of eight years (Article 7.1 and 7.3) and limiting repeated application of safeguards with respect to a given product (Article 7.5). The agreement also has in place provisions to encourage structural adjustment, for example by requiring evidence that the industry is adjusting to be presented in order to allow an extension (Article 7.2). It also requires safeguard measures in place for longer than one year to be progressively liberalised at regular intervals during the period of application (Article 7.4). 14. The Anti-dumping agreement, because it governs the application of anti-dumping measures which are a legitimate remedy to counter unfair dumping of products, does not foresee any structural adjustment to take place, and has no provisions related to adjustment. It does, however, provide for periodic review and includes a sunset requirement which establishes that dumping duties shall normally terminate no later than five years after first being applied, unless a review investigation establishes likeliness of continuation or recurrence of dumping and injury. 15. The case of petrochemicals in China points to the country s increasing use of anti-dumping duties 12 even while the global use of anti-dumping measures have peaked in The wide range of countries subject to anti-dumping duties in the case of chemicals in China raises some doubts as to whether anti-dumping duties are being used for their intended purposes to counter unfair dumping of products. Improper use of anti-dumping duties in lieu of safeguards may impede structural adjustment as there are no in-built mechanisms to facilitate adjustment. Improved transparency would improve the situation for exporters who might be subject to anti-dumping investigations, to ensure they are treated fairly and due process is afforded to them, while maintaining the legitimate right for a domestic industry to seek recourse to trade remedies. Trade liberalisation can facilitate the structural adjustment process by providing markets for new products and industries 16. Structural adjustment typically entails the movement of factors of production out of one industry (a declining or uncompetitive sector or in some cases a sector where rapid improvement in productivity has freed up resources) into another (new or expanding industries). Many developing countries have small domestic markets where new industries have much to gain from access to foreign markets. Tariff reductions by other countries through trade liberalisation initiatives may allow developing countries with small domestic markets to achieve economies of scale. Reduction of their own tariffs will encourage 12. See Para 286 and Tables 20 and While the number of anti-dumping investigations has increased since the 1980s, the numbers appear to have stabilised. Anti-dumping investigation initiations peaked in 2001 at 364 but has fallen steadily since then to 191 in India, China, the European Communities and South Africa reported the highest new initiations in China was by far the most frequent subject of new investigations during the same period followed by Indonesia, Chinese Taipei, India and Malaysia 12

14 competition in the domestic market, preparing domestic producers for competition in the export market and permit access to more competitive inputs. The development of the chemical sector in East Asian countries has been enhanced by multilateral trade liberalisation, tariff reductions at the regional level (e.g. under the Asian Free Trade Agreement [AFTA]) and tariff reductions by China. 14 The tariff reductions helped create a sizeable market in which companies could compete and achieve more efficient production. 17. Nowhere is the need for diversification higher than in countries dependent on a limited number of commodities for export revenue because they are particularly sensitive to volatile or declining commodity prices. 15 The coffee case shows that many coffee-producing countries are highly dependent on coffee for export earnings. Few coffee-producing countries, with the notable exception of Brazil, have moved up the supply chain to export processed coffee products. One of the impediments may be tariff escalation. 16 While tariffs are falling for all coffee products and preferences provided under the General System of Preference may alleviate the problem, tariffs on more processed products continue to be higher than tariffs on green coffee beans in some developed and developing countries. Flattening the tariff profile for coffee may be one of several steps to help small coffee producing countries to adjust. (2) How domestic regulations can facilitate or hinder structural adjustment 18. Domestic regulations are a key determinant in the framework for structural adjustment. As tariffs and various border measures have been lowered or eliminated, the relative importance of domestic regulation has increased. Domestic regulations are increasingly becoming relevant in the context of multilateral trade rules. Domestic regulations such as licensing and production quotas reduce competition, opportunities for investment and the private sector s ability to adjust to structural changes 19. An important lesson in all three sectors studied is that regulations which restrict market entry may reduce competition, opportunities for investment and the private sector s ability to respond efficiently to market signals, which impedes structural adjustment. Licensing, production quotas, or other barriers to entry may be put in place to achieve certain legitimate policy objectives. However, when combined with other trade barriers, they may effectively shield product markets from competition. Lack of competition reduces incentives for change. Entry barriers will preclude innovators from taking advantage of opportunities for investment. It may also create vested interests which oppose and delay adjustment. Therefore, domestic regulations that pose restrictions to market entry need to be reviewed regularly. 20. The US tobacco case provides an example of a quota system which had a built-in adjustment mechanism which reflected changes in market conditions. The data show that the US tobacco industry went through considerable restructuring in response to changing market conditions. However, even with this regular monitoring of the quota, the US producers did not adjust sufficiently to market changes, leading to gradual loss of market share in both domestic and foreign markets. 17 In Brazil, the lifting of export quotas in coffee led to increased competition and production; 18 the export quotas may have shielded producers from market signals causing producers to pass over export opportunities. 14. See para 278 and Figure See para See Figure See also para 70 and 71 and Table See para and Figure 30 for discussion of tobacco quotas in the US and para and Figures for tobacco production in the US. 18. See Figure 14 and para

15 21. The telecom case illustrates how competition together with technological change has led to product and process innovation, which resulted in the creation of new industries, and led to higher demand and economic growth in many countries. The reduction of entry barriers increased competition which led to a virtuous cycle of greater investment, lower prices, and higher demand. The chemical case illustrated how, in the wake of the Asian financial crisis, foreign investment regulations were relaxed and bankruptcy laws reconsidered to facilitate restructuring in many Asian countries. 19 The studies point to the benefits of reviewing regulatory regimes, especially ones restricting entry and exit, to ensure that growth opportunities are not passed over. 22. In the area of goods, market entry restrictions can take such forms as regulatory barriers, import licensing and/or investment restrictions. Some of these issues are to some extent addressed by various WTO Agreements (Agreement on Technical Barriers to Trade, Agreement on Import Licensing Procedures, etc). In the area of services, Article VI of the GATS states that domestic regulations must be administered in a reasonable, objective and impartial manner and any necessary disciplines shall be developed with a view to ensuring that measures relating to qualification requirements and procedures, technical standards and licensing requirements do not constitute unnecessary barriers to trade in services. This provision would be applicable even to entry barriers that are implemented on a non-discriminatory basis. Although work on disciplines related to domestic regulations in services is progressing, concrete progress has been relatively limited until now. Having clearer disciplines in this area may facilitate future structural adjustment by facilitating market entry in the area of services. State-Owned Enterprises (SOEs) in certain sectors may delay the structural adjustment process 23. State ownership may be considered an extreme form of domestic regulation which reserves certain sectors of the economy to the state and is a policy tool that affects trade and investment. In many countries, both developed and developing, state-owned enterprises (SOEs) have played a direct role in the economy in certain industries such as telecommunications or petrochemicals. 24. While SOEs may be seen as successful in achieving certain government objectives, they may not necessarily respond to market signals in the same way as private firms in a competitive market. If stateowned enterprises are slow to respond to changing markets, they may delay the structural adjustment process. Experience has shown that SOEs may also be subject to political pressures, e.g. to abstain from workforce reduction. This may especially be the case where top positions in state-owned enterprises are appointed by politicians. Political pressure to maintain employment in petrochemicals in some countries in Europe and Mexico were examples of such constraints. 20 Moreover, if employees in SOEs are granted strong employment protection, as is the case in the telecommunications sector in many countries, this may negatively affect incentives to adjust at the worker level. 25. An important lesson emerging from the petrochemical industry is that state-ownership, especially in an industry lacking competition, may have detrimental effects on structural adjustment. Easy access to government funding may have allowed SOEs to continue to invest even in the face of over-capacity. 21 In the case of petrochemicals in Mexico, state ownership may have been one of the reasons for underinvestment or delays in investment. 22 Privatisation may be a part of the answer as could be seen in the fact 19. See para See para and Table 22 for example of Mexico. According to Greco (2004), political control of placement decisions for management personnel was one of the major reasons for over-manning in state owned enterprises in Italy See para 255 for Chemicals in Europe. See also footnote See para

16 that partial privatisation of telecommunications companies in Morocco and Argentina resulted in new investment and rising subscriber levels. However, as noted in Bertero(2002), privatisation per se does not necessarily create the right financial incentives and should not be considered a panacea. 26. Currently, international rules related to state-ownership are quite limited. 23 The Agreement on Subsidies and Countervailing Measures, which provides rules on subsidies also cover SOEs. Thus, financial contributions by a government to an SOE may be prohibited in certain cases and may be subject to countervailing duties. To the extent that state-owned enterprises in certain sectors impede structural adjustment and may lead to potential cross border problems, there may be a case to reconsider rules in this area perhaps in conjunction with rules in the area of subsidies. (3) Role of the Public and Private Sectors: Facilitating Entry and Exit While the private sector remains the main player in structural adjustment, governments also have opportunities to play a constructive role. 27. As emphasised in OECD (2005), the private sector -- firms and individuals -- are the main drivers of the structural adjustment process. Government may also be important, especially in areas where there is state ownership (as in some cases regarding petrochemicals and telecommunications), or where there are existing government regulations which place direct restrictions on entry to or exit from a certain sector (tobacco farming in the US, 24 telecommunications and chemicals when subject to strict investment regulations) as stated in the previous section. Indeed, in such cases government action may be a prerequisite for structural adjustment. 28. The government also may play a key role by providing a broad policy environment that is conducive to market entry and exit, which is the heart of the adjustment process. The European chemicals case illustrates how changes in competition policy in response to the Single European Market opened the way for the mega-mergers. The Tanzanian coffee case illustrates a counter-example where lack of institution building may have kept Tanzania from fully benefiting from market liberalisation. 25 Direct government intervention in the structural adjustment process needs to be handled with care 29. While direct government intervention may be warranted in some cases and may facilitate adjustment, it can lead to an inefficient outcome. Although it would be desirable for inefficient players to reduce production or exit the market, governments often choose to promote reduced production industrywide on a pro rata basis, in order to avoid choosing among producers. While this may facilitate partial adjustment, such solutions penalise efficient producers and allow inefficient producers to stay in the market. 23. Examples are (i) GATT Article XVII on state trading enterprises (STE), which provides that STEs are to act in accordance with the principle of non-discrimination and that purchases and sales are made in accordance with commercial considerations, and (ii) GATS Article VIII on Monopolies and Exclusive Service Suppliers, which ensures that monopoly positions are not abused to negate specific obligations made in the GATS. 24. It should be noted that the US tobacco quota system did allow for lease and transfer of tobacco quotas within counties. 25. Before market liberalisation, Tanzania was able to control quality effectively as the Tanzanian Coffee Marketing Board had complete control of the marketing chain. However, it failed to put in place the necessary institutions for quality control in a liberalised market. Thus, quality control procedures, although they existed on paper, were rarely enforced, leading to a general deterioration of quality. See also para for discussion on coffee in Tanzania. 15

17 30. The petrochemicals case in Japan illustrates this point. Japan successfully reduced capacity in petrochemicals in the 1980s through pro rata reductions. However, government intervention had major drawbacks: The reductions delayed the consolidation of the industry by preserving inefficient players, may have amplified over capacity problems later on, 26 and may also have led to some moral hazard problems in subsequent periods as industry took a wait and see attitude. Such government actions may also have negative effects on other industries if it establishes a precedent. Subsidies or other governmental action, to minimise social dislocation should be transparent and time bound. 31. Governments use various types of subsidies or financial incentives to influence private sector activities and to achieve policy objectives. For example, regional subsidies may be used to achieve more geographically balanced development. Government intervention and subsidies may be considered desirable to provide compensation or to minimise social dislocation related to structural adjustment. Subsidies may also be used to cushion producers from short-term problems, like low prices in a cyclical market. However, subsidies should be approached with caution as they may have unintentional side effects. 32. Regional subsidies provided to some companies in the European petrochemical industry were perceived to be at least part of the reason for the excess capacity in the 1980s. 27 Regional subsidies, if provided on an ongoing basis to producers, allow inefficient producers to survive, and numb even efficient producers ability to sense change and to adjust to changing market conditions. The subsidies may also cause trade problems by exerting additional competitive pressures on other producers both at home and abroad. Regional subsidies by their very nature, will have a geographically limited scope and would be actionable under the SCM Agreement. 33. Subsidies to provide compensation or to minimise social dislocation related to policy reform should be used with care. Where there is a policy-induced change as opposed to a market-based change, there may be a stronger case for compensation as the former is something that is induced by government action. Governments are recommended to rely, wherever possible, on generally available measures of adjustment costs (OECD2005), but some targeted measures may be considered necessary on a case by case basis. A paper by the Productivity Commission of Australia states that the case for measures to compensate for policy-induced change would be strongest from equity and fairness grounds if a reform: will impose a clear and sizeable burden on a specific group (particularly if the affected group is relatively disadvantaged); delivers benefits mainly to relatively advantaged groups; or involves a largely anticipated and material change to a well defined and defensible property right ) (Productivity Commission 2001). 34. The EU and US tobacco case were cases where compensation packages were put in place to assist individuals whose wealth was in part based on the quota. 28 Reductions in these quotas could be considered as changes in defensible property rights, which may fit the above criteria. Such compensation was likely considered necessary to gain political support for reform. However, it should be noted that there is a risk of creating a general precedent of compensating beneficiaries who lose as a consequence of any changes in government policy. All changes in government policy create both winners and losers. Expectations for compensation once built up may make structural adjustment in other sectors more 26. As capacity reductions were calculated based on existing capacity, companies had an incentive to maintain old capacity and make investment decisions quickly for fear of being precluded from making those investments at a later date. See para for Japan s experience in ethylene capacity reduction. 27. See para 255, Box 14 and para 266 for discussion on subsidies in Europe. 28. See para for description of the US Tobacco buyout and para 147 for the new EU policy on tobacco. 16

18 difficult. It may also have the perverse result of inducing potential beneficiaries of compensation to lobby harder against policy reform in order to increase the amount of compensation. 35. Government intervention and subsidies may also be used to minimise social dislocation by delaying structural adjustment; e.g. by rescuing and restructuring firms in difficulty. However, care is necessary as aid for restructuring purposes raises particular competition concerns as it can unfairly shift the burden of structural adjustment on to other, more efficient producers who are managing without aid (EC 2005). Unnecessary delay of the structural adjustment process may also lead to greater and more difficult adjustment later on. In chemicals, countries such as the US who have left adjustment to market forces, while experiencing some falls in employment, have recovered relatively quickly. 29 Some countries who delayed structural adjustment seem to have experienced longer periods of structural adjustment with greater falls in employment in the end Governments sometimes grant subsidies in order to cushion producers from short-term problems like low prices. However, care is needed to ensure that the nature of the problem has been correctly assessed and that this type of subsidy is indeed an appropriate response. Subsidies to solve short-term problems are unlikely to provide solutions to underlying long-term structural change. For example, direct payments provided to coffee producers in Central American countries may have been an appropriate governmental reaction if low coffee prices were a cyclical phenomenon. However, if this were not the case and low coffee prices represented a structural change, these subsidies may have the unintended effect of keeping producers in coffee production and benefit certain producers over others The fact that subsidies may distort trade and investment is widely recognised. The Agreement on Subsidies and Countervailing Duties defines three categories of subsidies: prohibited, actionable and nonactionable subsidies. Export subsidies and subsidies which are contingent on use of domestic over imported goods are prohibited with some limited exceptions, 32 and if found to exist they must be withdrawn. Actionable subsidies may be subject to WTO Dispute Settlement or to the imposition of countervailing duties if found to cause serious prejudice or injury to the domestic industry of another Member. Article 8 defining non-actionable subsidies have become non-operational in accordance with Article 31 of the SCM so all the above mentioned subsidies will be considered actionable. Certain subsidies have also been subject to non-violation claims under GATT Article XXIII (b) However, the effectiveness of current multilateral rules may be limited as it is often difficult to have subsidies removed through the WTO Dispute Settlement Mechanism. Moreover, countervailing duties may not be practical if the results of excess capacities do not result in the increase of imports, but rather result in depressed international prices, loss of exports, etc. Subsidies for firms in financial distress may be detrimental if as a result of subsidies, the less efficient but subsidised firms survive while more efficient firms that are not subsidised are forced to exit. 29. See para for discussion on restructuring of the chemical industry in the United States. 30. See para 255 and 261. See also Box See para for description of adjustment policies in Central America. 32. For example, Article 13 of the Agreement on Agriculture for agricultural products and Article 27 for some developing countries 33. In an adopted GATT panel report EEC Oilseeds I, the Panel found that benefits accruing to the United States were impaired by introduction of production subsidy schemes which operate to protect Community producers of oilseeds completely from the movement of prices of imports and prevented tariff concessions from having any impact on the competitive relationship between domestic and imported oilseeds. The panel recommended that the CONTRACTING PARTIES suggest that the Community consider ways and means to eliminate the impairment of its tariff concessions for oilseeds. 17

19 39. There may be a case to consider additional multilateral rules in this area; 34 in this case, some differentiation between developed countries and developing countries may be warranted as developing countries economies are less diversified and markets are less developed. However, experience has shown that subsidization policies which shield industries from competition for extended periods are not an effective economic development tool. Therefore, provisions on special and differential treatment for developing countries should be viewed as temporary deviations from the normal disciplines necessary to promote trade liberalization and growth, and should only be invoked to the extent necessary and consistent with an individual country s particular economic, financial and development needs. Decentralisation of adjustment policies have its pros and cons 40. Structural adjustment policies that limit adjustment costs for all groups that are severely affected would be preferable. However, because of the differential effects of structural reform, it is often difficult to pre-define the effects of structural adjustment on any given group, and a single policy (or group of policies) may not always be possible. In these cases, a realistic approach may be to move ahead with reform while providing flexible and disaggregated adjustment policies. Aid at sub-national levels may have the advantage of being based on local information about the precise locally-based changes and allows for more targeted policies. Some support payments in the case of U.S. tobacco may be examples of this dis-aggregation of assistance. 35 As is the case with national policy, these structural adjustment measures must be time-bound, with a clear exit strategy. Care is needed to ensure that adjustment aid at sub-national level does not conflict with structural adjustment policies at the national level as they may also slow down the structural adjustment process. Public-private partnerships may be effective in a world of imperfect information and market imperfections 41. One of the differences between developed and developing countries, as between large companies and individuals, lies in their ability to analyse structural changes. Although information technology has greatly enhanced the ability to accumulate information, each individual worker, firm, or country must analyse the effects of changing trends on one s own economic activity. The ability to do this analysis may vary. If economic players detect change only when the effects are clear and apparent, it may be too late, and resources may have been wasted in unproductive activities. 42. Governments and international and national industry associations may play a constructive role in analysing the implication of structural trends to an industry/country. This is because firms and workers are better able to adapt to the changing environment if they have a better idea of how the environment is changing and how it is expected to evolve. This could be seen for example in the policy dialogues throughout the structural adjustment planning process for US tobacco 36 and in the role of the Association of Petrochemical Producers in Europe (APPE) in the chemicals industry in Europe. 37 Analysis of markets through public-private dialogue may be helpful in alerting industry and workers of structural change, as well as facilitating a better understanding of markets by the government. The process may be just as important as the resulting analysis. Market projections coupled with direct intervention may have negative 34. Bertero (2002) has argued that a supranational institution may have the effect of imposing financial discipline on governments and state-owned enterprises operating in a soft budget regime through a case study analysing the effect of European Commission policy on the budget regime in Italy. 35. See para 131 for description of direct payments to farmers at the state level under the Master Settlement Agreement in the US tobacco industry. 36. See para for the US tobacco case. 37. See para

20 consequences. 38 The public-private partnerships in Brazil tobacco and the work of the agricultural producer associations in the tobacco case show that structural adjustment can be assisted not only by the government but by the active participation of the private sector and NGOs. 39 Foreign direct investment may facilitate the structural adjustment process by providing capital, new technology, access to foreign markets, and information on the global market 43. In most cases, foreign direct investment (FDI) has played a key role in the restructuring of industries in both developed and developing countries. 40 Multinational enterprises have facilitated structural adjustment through international transfer of technology, capital, managerial expertise and marketing know-how. One thing worthy of note is that investments from developing countries to developed countries may also be beneficial for structural adjustment. Acquisition of Western European companies by Middle Eastern chemical companies allowed Middle Eastern companies to acquire technology and gain market footholds while allowing European companies to focus more on growth areas such as specialty chemicals FDI has played a role even in agricultural sectors such as tobacco. For example, the FDI from Philip Morris is providing new opportunities for tobacco production in its India partner: through the potential development of new hybrids, quality improvements and higher yields. Philip Morris is also benefiting from their partner in India because of access to a new variety that better meets consumer demand. FDI has helped to link developing country producers with developed country markets. This linkage has been mutually beneficial for both parties so that both could capitalise on the new opportunities of the changing tobacco market. 42 (4) Possible Lessons on Sequencing and Pace of Policy Reforms 45. As stated in OECD (2005), while no single blueprint for sequencing exists, the cases point to some possible lessons on the sequencing and pace of reform. While it is necessary to bear in mind the uniqueness of sectors and the general context under which the structural adjustment takes place, it may have some implications for other sectors. Attention to sequencing of reform may lead to better results 46. The case of telecommunications services illustrated that a country s success in establishing competitive markets was dependent on the sequence of implementing reform measures. 43 Three main elements of reform were identified in the telecommunications services sector: privatisation, introduction of competition and establishment of an independent regulator. While it is possible to pursue one or the other sequentially, several studies show that all the elements of reform are mutually reinforcing. Competition is the most effective agent of change, acting as a spur to innovation and strengthening firms incentives to adopt best practices and respond to customer needs. It could also lead to the reduction of rents and 38. The case of petrochemicals in Japan in 1980s may be a case of direct government intervention. See para and para See para 153 for public private partnership in Brazil tobacco. 40. See para 252 for US Chemicals, para 260, 265 and 267 for Europe, para 278 and para 279 for Asian countries. For telecommunications see para See para See Box See para for further discussion on sequencing in the telecom sector. 19

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